Just last month, we wrote about a North Carolina draft proposal that would ease the way via its ethics rules for Avvo and other on-line legal services to operate there. Now, after a joint opinion from three New Jersey Supreme Court committees, the Garden State has turned thumbs down on such law platforms, citing issues including improper fee-sharing and referral fees.

Nix on Avvo, LegalZoom, Rocket Lawyer

The joint opinion bans participation in Avvo’s programs because of the “marketing fees” it collect from lawyers in exchange for participating in two of its offerings: “Avvo Advisor,” in which clients talk to lawyers for 15 minutes for $40, with Avvo keeping $10; and “Avvo Legal Services,” where clients pay a flat fee to Avvo for access to affiliated lawyers, and then Avvo pays the lawyer net of its own fee.

The committees found that this arrangement violates New Jersey’s version of Model Rule 5.4(a), barring fee-splitting with non-lawyers, and it mattered not that Avvo called its cut a “marketing fee”: irrespective of its label, said the committees, “lawyers pay a portion of the legal fee earned to a nonlawyer; this is impermissible fee sharing.” In addition, said the committees, these payments signal a “lawyer referral service,” and payment of an “impermissible referral fee” under New Jersey’s Rules 7.2(c) and 7.3(d).

Icing the cake, the committees also raised a trust account issue, saying that Avvo’s practice of holding the lawyer’s fee until the conclusion of the matter violates the attorney’s duty to maintain a registered trust account and to hold client funds in it until the work is completed.

Avvo wasn’t the only on-line platform tagged — Rocket Lawyer and LegalZoom also were placed off-limits to New Jersey lawyers, but for a different reason. While they do not require payment from lawyers to participate, and do not share the clients’ monthly subscription fees with lawyers, Rocket Lawyer and LegalZoom are “legal service plans” that have not been registered with or approved by the New Jersey Supreme Court, said the committees. That places them outside the pale, even while not violating the fee-sharing prohibition.

A notice to the bar from the supreme court’s administrative office accompanied the joint opinion, listing the 46 state-approved legal service plans, including those offered through unions and government agencies.

What next?

As we’ve noted, the ABA’s Futures Commission sees the continuing onslaught of on-line platforms as something that is here to stay. Nonetheless, this New Jersey ethics opinion joins other cautionary or negative ones issued by regulators in Ohio, Pennsylvania and South Carolina. Against that backdrop, North Carolina’s recent consideration of rule changes may appear to be the outlier (although an Oregon state bar association task force also recently recommended ethics rule amendments that would be friendly to on-line service legal platforms).

Avvo responded to the New Jersey opinion, telling the New Jersey Law Journal that it is “attempting to address the pressing need for greater consumer access to justice, and we will continue to do so despite this advisory opinion.”

Will market pressure become a tsunami that will eventually sweep legal ethics considerations away? It may take awhile to tell, but until then, look for more ethics opinions to come out with differing views, potentially creating a patchwork of inconsistent state approaches. We’ll be watching with great interest.

Litigation funding is in the news again, with the U.S. Chamber of Commerce spearheading a request to amend the Federal Rules of Civil Procedure to require initial disclosure of all third-party agreements for compensation that are “contingent on, and sourced from, any proceeds of the civil action, by settlement, judgment or otherwise.”

The Chamber joined with 28 other organizations in a letter sent earlier this month to the federal courts’ Rules Committee, saying that its aim is to bring third-party litigation funding out of “the shadows” and to identify “a real party in interest that may be steering a plaintiff’s litigation strategy and settlement decisions.”

The new push follows up on a 2014 proposal that the Chamber and a few other organizations made to the same rulemaking committee, which was rejected. Things have changed since then, the Chamber’s June 1 letter said, citing expansion of third-party funding in the U.S., with several significant players reporting significant and steady growth, and on-line marketplaces opening the way for investors to shop for individual cases to contribute to.

Shift in momentum?

As we reported in February, the U.S. District Court for the Northern District of California became the first court to mandate disclosure of litigation funding that parties in class actions receive from outside sources, under a revision to the court’s standing order. That was followed up in March, when the U.S. House of Representatives passed the Fairness in Class Action Litigation Act of 2017, which likewise would require disclosure of third-party funders in class actions. The bill is now before the Senate Judiciary Committee.

The champerty problem. This old legal doctrine, which seeks to prevent buying and selling lawsuits, still continues to be in play, with at least three state courts of appeals citing it or suggesting it as a viable defense in 2016-17, and a U.S. bankruptcy court in January finding an agreement to be champertous.

Fee-sharing issue. Model Rule 5.4(a) bars almost all forms of sharing legal fees with non-lawyers, with the goal of preserving the lawyer’s independent professional judgment. But some models of third-party litigation funding apparently involve plaintiffs’ counsel repaying the funder’s investment out of the lawyer’s attorney fees, if any.

Confidentiality and conflicts. To the extent that funding arrangements require disclosure of client information to the financier they could raise confidentiality concerns under the ethics rules, as well as privilege issues. And lawyers who have “contracted directly with a funding company may have … duties to it that are … perhaps inconsistent with” the duties of loyalty to the client, including conflicts arising from steering clients to favored funders.

Watch and wait

In a press release, one large litigation funder, Bentham IMF, said that the Chamber’s proposal was misguided, including because the law firms using such financing were assisting under-served and under-funded clients — small-to-mid-size businesses and individuals — who could not otherwise afford to litigate their claims. Bentham also said that the rule amendment proposal was unfairly one-sided, and that defendants should have to abide by similar disclosure rules.

Litigation funding will continue to be a hotly debated issue, and if your clients are involved in civil litigation, these are developments that bear watching. Stay tuned.

Avvo Legal Services has been meeting with North Carolina bar regulators, resulting in a draft proposal that would amend several legal ethics rules and make it easier for Avvo to operate in the Tar Heel State, according to Prof. Alberto Bernabe, a Chicago law professor who has seen some of the relevant documents, and blogged about them last week.

Ethical problems?

Several state legal ethics opinions have recently found client-referral services using an Avvo-like model to be ethically problematic, including opinions from regulators in Pennsylvania, South Carolina, and my home state, Ohio. Rule revisions in Florida now pending for approval by the state supreme court there likewise call aspects of the model into some question.

Some of the identified ethical issues raised by Avvo-like referral services, as identified by various ethics opinions are:

the company — and non-lawyers — control significant aspects of the attorney-client relationship, including functions that can constitute the practice of law (see Model Rule 5.5(a));

the structure can interfere with the lawyer’s exercise of independent legal judgment on behalf of the client (see Model Rule 5.4(c));

the way the fees are managed could constitute or invite commingling of clients’ funds and lawyers’ funds (see Model Rule 1.15(a));

the fee structure makes it difficult to comply with the duty to refund unearned fees at the end of the representation (see Model Rule 1.16(d));

a model where the lawyer is paid only after the representation is concluded makes the fees contingent on the outcome, which can violate the prohibition on contingent fees for certain kinds of cases (see Model Rule 1.5(d));

receiving and holding client funds paid in advance may violate the lawyer’s duty to hold those funds in a trust account (see Model Rule 1.15(c));

although part of the fee paid by the client and kept by the company may be designated as a “marketing fee,” the fact that such fees are calculated as a percentage of the full fee makes the arrangement likely to be impermissible fee-splitting with a non-lawyer (see Model Rule 5.4(a));

the business model can threaten the confidentiality of the lawyer-client relationship (see Model Rule 1.6).

North Carolina considers amendments

In light of these issues, Avvo has tried to allay concerns, including by saying that its model actually comports with ethics rules, and that it is providing advertising that is protected by the First Amendment. (A recent Georgetown Law Journal article by Prof. Bernabe details Avvo’s arguments.)

According to Prof. Bernabe, North Carolina may now be considering a different regulatory approach: amending its lawyer conduct rules to “make it acceptable for lawyers to participate in services like Avvo.”

Documents he has seen include a proposal to amend the fee-splitting rule to permit payment of a portion of the lawyer’s fee to an on-line platform if the amount is a reasonable charge for administrative or marketing services and there is no interference with the lawyer’s independent professional judgment.

Another proposed comment amendment would allow lawyers to participate in Avvo-like rating services without fear of being held in violation of the prohibition against giving something of value in exchange for a recommendation of employment. (See Model Rule 7.2(b).)

Yet another amendment would allow the company to keep the client’s payment until the end of the representation, imposing on the lawyer the obligation of ensuring that such “intermediaries” “adequately protect client funds” — instead of placing such advance payments in the lawyer’s trust account.

Brave New World

Although nothing is certain yet, and the documents that Prof. Bernabe describes are certainly preliminary and might be incomplete, the path that North Carolina appears to be contemplating significantly departs from the road that bar regulators in other jurisdictions have so far taken. Whether acquiescing to market trends — even ones that seem to be irresistible — is in the true best interest of legal consumers and the legal profession remains to be seen.

Following an $8 million settlement in a personal injury suit, the New York Court of Appeals held that a fee-sharing agreement between two lawyers was enforceable, even though it violated ethics requirements. The court said that counsel’s failure to inform her client and obtain consent to the fee split was a “serious ethical violation,” but it did not allow her to sidestep the otherwise-enforceable contract. The unanimous February 9 opinion in Marin v. Constitution Realty, LLC seems to go against a developing trend toward voiding unethical fee-sharing agreements.

Failure to disclose to client

The case involved serious injuries to a construction worker who fell from a Manhattan building. Counsel of record hired co-counsel and agreed to pay him 20 percent of the attorneys’ fees if the case settled before trial. However, no one informed the client of the agreement or obtained his consent, although there was evidence that counsel of record had led her co-counsel to believe that the client had been informed. Just six months later, counsel fired the co-counsel and advised him that his portion of any fee would be based on quantum meruit. Three years later, the case settled for $8 million. Co-counsel moved to enforce the fee-sharing agreement.

Fee-splitting requires client disclosure

Every jurisdiction in the country has some form of Model Rule 1.5(e), which permits fee sharing between lawyers who are not in the same firm, but requires that the client agree to the arrangement in writing, including the share that each lawyer will receive.

Affirming the trial court and the intermediate court of appeals, the New York high court held that the failure to disclose to the client and get his consent did not void the fee-sharing agreement, as counsel of record had argued.

Quoting from its 2009 opinion under the former Code, the court said “it ill becomes defendant … to seek to avoid on ‘ethical’ grounds the obligations of an agreement to which [she] freely assented and from which [she] reaped the benefits.” The court said that having benefitted, counsel could not “use the ethical rules as a sword” to invalidate the fee-sharing agreement.

Not the majority view?

Although the Marin court did not consider the Restatement (Third) of the Law Governing Lawyers, the opinion likely accords with the view set out in § 47, which says that “a lawyer who has violated a regulatory rule or statute by entering into an improper fee-splitting arrangement should not obtain a tribunal’s aid to enforce that arrangement, unless the other lawyer is the one responsible for the impropriety.” Here, as the court noted, co-counsel, who was trying to enforce the agreement, thought that counsel of record had informed the client, which under the Restatement analysis might suggest that the “other lawyer” was responsible for the ethics breach.

But more broadly, there seems to be an emerging majority view that fee-sharing arrangements that don’t comply with Rule 1.5(e) are simply invalid. See Benjamin C. Cooper, Taking Rules Seriously, 35 Cardozo L. Rev. 267 (Oct. 2013) (a “significant majority of the courts [that] have looked at the issue conclude that such agreements are unenforceable,” citing cases). The justification for that position is that it would be against public policy if a lawyer could enforce an unethical fee agreement through court action, even though the lawyer would be subject to discipline for entering into the agreement. However, as Marin illustrates, there are opinions that come out the other way.

Take care before you share

It seems self-evident that the best way to stay out of trouble is to comply with the client-disclosure-and-consent requirement of your jurisdiction’s version of Rule 1.5(e). But if you are involved either in trying to enforce or to invalidate a fee agreement that does not comply with the rule, you will need to weigh the relevant case authorities carefully, in light of the divergent approaches that courts have taken.

On January 26, the U.S. District Court for the Northern District of California became the first court to mandate disclosure of litigation funding that parties in class actions receive from outside sources, under a revision to the court’s standing order applicable to all cases. The rule provides that “in any proposed class, collective or representative action, the required disclosure includes any person or entity that is funding the prosecution of any claim or counterclaim.”

Final rule — more “funder friendly”

The final rule is more limited than an earlier draft, which would have expressly mentioned “litigation funders,” and required their identification in the first appearance in all civil proceedings.

The court’s request for comments on the earlier draft, during summer 2016, drew input from two large litigation funders. The CEO of Burford Capital, which calls itself “the largest provider of strategic capital to the legal market,” criticized the earlier draft proposal as “unnecessary and discriminatory” in a comment he filed in July. He told Law360 (subs. req.) that Burford was happy with the district court’s “incremental approach” to disclosure reflected in the final rule.

Another litigation funder, Bentham IMF, based in Australia, also commented this past summer on the earlier draft rule, expressing concern that it would open up wasteful “discovery sideshows,” intrude on attorney-client privilege and “give defendants in all cases the unprecedented and unintended advantage of knowing which claimants lack the resources to weather a lengthy litigation campaign.”

The U.S. Chamber of Commerce has supported disclosure of litigation funding, and told Law360 that the rule would force law suit investors out of the shadows, where they shouldn’t be allowed to control litigation, especially in class actions.

A growing segment — but is it champerty?

In its comments, Burford said that commercial litigation funding is in its infancy in the U.S., and that fewer than 75 cases in federal district court involve such funders each year. That limited figure would appear to exclude the many other forms of third-party funding available to plaintiffs and investors. And the market for litigation investing is lucrative and growing, according to Forbes, which headlined a story last year “The next great investment idea: Somebody else’s lawsuit?”

The doctrines of champerty and maintenance were developed at common law to prevent officious intermeddlers from stirring up strife and contention by vexatious and speculative litigation which would disturb the peace of society, lead to corrupt practices, and prevent the remedial process of the law.

The modern trend has been away from applying these old doctrines (which some jurisdictions codify by statute) to third-party funding agreements, as exemplified by a Delaware trial court decision last summer, involving Burford Capital. And the 2003 Ohio ruling, which voided a contract as champerty and maintenance, was later abrogated by statute.

Some courts, however, are sticking to the champerty analysis. For instance, a recent decision of the Pennsylvania court of appeals held that “champerty remains a viable defense in Pennsylvania,” invalidating a third-party funding agreement between plaintiff’s lawyer and the funder. New York’s highest court this fall likewise interpreted a litigation funding transaction to be a sham attempt to evade the state’s champerty statute.

Trendline to watch

It will be interesting to watch the trend toward a growing litigation funding marketplace as it meets up with a possible push for more disclosure and a potential resurgence in champerty jurisprudence. Stay tuned.

In today’s soft legal services market, some aspiring members of the profession feel pressure to work for free, but the fairness of such arrangements in general has come under scrutiny. In a twist (and just in time for the summer crop of interns), the New York State Bar Association earlier this month said that law firms can bill clients for services provided by unpaid legal interns, as long as the amount is not excessive, and the internship program complies with applicable law. If charged to clients as an expense, the law firm can build in its overhead costs, such as for supervising the intern, the Committee on Professional Ethics said in its Opinion 1090.

U.S. DOL standards judicially rejected

Last summer, the Second Circuit refused to apply U.S. Department of Labor standards barring employers from deriving immediate economic advantage from unpaid interns, in favor of a non-exhaustive set of considerations that focus on what the intern receives in exchange for the work. The ruling overturned the grant of class certification in a wage case against Fox Entertainment. The Second Circuit also upheld a trial court denial of class certification in another intern wage case against Hearst Corp.

Many law schools place students with private-sector employers who do not pay them; but the interns do benefit in some cases by getting academic credit. Whether and how clients can be billed for the work of such credit-earning interns was the subject of a law firm inquiry.

Billing intern work as fees vs. expenses

In response to the inquiry, the NYSBA ethics committee said that there was nothing in the state’s ethics rules that would prohibit a law firm from billing clients for the services of a law student-intern on either a fee basis or as an expense to the firm, even if the firm didn’t pay the intern or the law school.

The state’s version of Model Rule 1.5(b) mandates communicating to the client “the basis or rate of the fee and expenses,” and under Rule 1.5(a), as interpreted by previous opinions, neither the fee nor any expenses may be “excessive” — defined as one where a “reasonable lawyer would be left with a definite and firm conviction” that it is too much. Nothing in the opinion appears to require the firm to inform the client that although the intern receives academic credit, the firm is not compensating the intern.

While the firm could bill the student’s work to the client as legal fees (by the hour or per task, for instance), the committee also approved the possibility of billing the work as an expense instead. In that case, the committee said, “the lawyer may charge the client ‘either … an amount to which the client has agreed in advance or … an amount that reflects the cost incurred by the lawyer’ to sponsor the intern (e.g., the cost of supervising the intern).”

In other words, although the law firm does not have any direct costs in connection with using an unpaid intern, it does incur overhead costs, and may peg the expense value of the intern’s work to include those costs to the firm.

ABA opinions on billing

The NYSBA’s opinion tracks the ABA’s 1993 opinion on billing issues. There, the ABA ethics committee said that in the absence of disclosure, it is improper to mark up expenses such as taxis and meals charged to the client unlessthe lawyer herself has incurred additional expenses beyond the actual cost of the disbursement item. Later, in 2000, the ABA’s committee expanded the same principles to cover the work of temporary or contract lawyers. This most recent New York opinion continues the same line of reasoning to support using the lawyer’s overhead cost to value an unpaid intern’s work when it is charged to the client as an expense.

The social justice aspect of using unpaid interns is hotly debated; but at least in New York, lawyers and firms have some guidance about the rules of the road in billing clients.

Bartering for goods and services seems old-fashioned, even primitive — after all, that’s why money was invented, right? But bartering might be viewed as a component of today’s “sharing economy,” which involves more-direct, Internet-facilitated interactions between consumers and providers.

A recent informal opinion of the Connecticut Bar Association Standing Committee on Professional Ethics advised that lawyers may participate in a barter exchange program and provide legal services to clients in exchange for receiving barter currency, which lawyers would then use to buy goods from other members of the barter exchange, rather than being paid for the services in cash by the client.

How barter exchanges work

Although there are many different models, a retail barter exchange is often a fee-for-membership organization in which the exchange basically acts as a clearinghouse for members, who use barter currency — fictional cash or credits issued by the organization — to exchange goods and services among themselves.

Legal services and the barter system

The Connecticut ethics committee identified several issues for lawyers participating in barter exchanges. But in sum, the committee said, the state’s Rules of Professional Conduct do not bar participating.

The committee offered the following specifics:

Lawyers don’t have to be paid in money. Comment [4] to Model Rule 1.5 says that “a lawyer may accept property in payment for services,” suggesting that even a straight goods-for-legal-services exchange would not be impermissible. But in any event, committee said, the barter exchange it was considering really was simply “substituting a different type of currency,” i.e., “barter currency instead of traditional dollars.” That fact apparently made the analysis more straightforward for the committee. Additionally, unlike in some jurisdictions, Connecticut lawyers are required to put all fee agreements in writing; the Connecticut ethics committee advised that lawyers must comply by explaining the special basis of the fee in the barter exchange context.

Fees paid to the barter exchange do not constitute sharing legal fees with non-lawyers. The organization under consideration charged participating lawyers (and everyone else) an annual membership fee and a percentage-based transaction fee. The committee said the annual fee was not fee-sharing proscribed by Rule 5.4, because it was not related to the lawyer’s fee at all. And the committee said “because the [percentage] fee is a surcharge on the transaction … as long as the fee is imposed uniformly on all Member transactions, it is permissible” under Rule 5.4.

So long as a barter exchange does not suggest or recommend the lawyer to members, it does not violate Rule 7.2’s prohibition against giving anything of value to a person for such a recommendation. The committee noted that the exchange didn’t push lawyer services to its members, and that there was no limit on the number of lawyers who could participate.

Lawyers must retain sole discretion to accept or decline matters from exchange members. Rule 5.4 bars a lawyer from allowing any third party to interfere with the lawyer’s professional judgment, and no barter exchange rules or regulations may impinge on that judgment.

Lawyers must maintain confidentiality. The duty of confidentiality under Rule 1.6 would preclude lawyers from sharing any client information with a barter exchange, including for example, detailed invoices (which should be conveyed directly to the client, the committee advised).

Advance fee payments may raise issues. The committee noted that “because barter money is fictional currency … and could not be held in an attorney’s trust fund,” as required by the state’s version of Model Rule 1.15, such barter money would only be permitted as advance payment under Connecticut’s Rule 1.15(d), which — unlike Model Rule 1.15 — says that “[a]bsent a written agreement with the client,” advance fees must be deposited into a client trust account and withdrawn only as earned.

The Connecticut opinion doesn’t discuss tax issues, which could introduce some complications for lawyers participating in barter exchanges. As the North Carolina State Bar’s 2010 opinion notes, federal tax law recognizes revenue from “trade” or “barter” dollars as taxable income, which must be reported using Form 1099-B. And ethics rules on the treatment of legal fees paid in advance vary considerably across jurisdictions. In jurisdictions with different rules than Connecticut’s there might be issues in a barter transaction where a lawyer receives plumbing services immediately, but “pays” with legal services that will stretch out over an extended period of time: are the plumbing services advance fees, and how will they be “withdrawn” only as earned?

Proceed with caution

As always, check your jurisdiction’s rules and ethics opinions, and seek advice as necessary. If you are in a jurisdiction that expressly approves participation in a barter exchange, it can be a neat way to get a different type of fee for your services — provided you adhere to the applicable ethics (and other) rules and limitations. And, as always, if you are not in such a jurisdiction, stay tuned — ethics rules and opinions are always evolving.

This week’s not-to-be-missed article on lawyer folly is a jaw dropping round-up of bad billing conduct, as reported in the American Lawyer.

It’s well-known that every jurisdiction’s version of Model Rule 1.5 prohibits charging an unreasonable fee or an unreasonable amount for expenses. So what could lawyers have been thinking when they did things like this:

• Billing a client for time spent showering, because that’s where the lawyer came up with his best ideas;
• Charging a client for lingerie because the lawyer failed to pack enough undies for the duration of a trial;
• Billing the client for a charter jet to send New York lawyers to review documents in Virginia, rather than hopping the shuttle that flew to Virginia every half hour;
• Billing for over 500 hours spent on a matter over the course of 15 days — an average of more than 33 hours per day;
• Billing a Washington, D.C. client for airfare, hotels, meals and travel time to bring in staff from the law firm’s West Coast headquarters — even though the matter was centered in D.C. and the firm had an office in D.C.

These whoppers are items that legal bill auditors have reportedly seen on fee bills, from mainly Am Law 200 firms. Clients are increasingly hiring such auditors, and pushing back on outrageous charges like these.

If you overbill, you can expect more than client push-back. In my home state of Ohio, several cases spotlight the disciplinary trouble that you can get into as well.

See, e.g., Cincinnati Bar Ass’n v. Alsfelder (unreasonable for an attorney to charge a client for “friendly advice” about personal relationships, restaurants and finances; advice was given at social occasions, and was unrelated to client’s legal needs; one year suspension stayed on condition of $30,000 restitution); Disciplinary Counsel v. Hunter (clearly excessive fee resulted from charging attorney rates for picking up mail, depositing checks, paying bills, and arranging for lawn care and house cleaning; disbarment for conduct that also included embezzlement from estate); Dayton Bar Ass’n v. Parisi(billing $13,000 in fees and expenses for overseeing partial restoration of client’s “beloved Jaguar” automobile constituted clearly excessive fee; six month suspension, stayed on condition); Disciplinary Counsel v. Johnson (overworking case and billing $160,000 to collect $197,600 resulted in excessive fee; one year suspension with six months stayed on conditions, including restitution).

The takeaways should be obvious. Be reasonable. Charge an appropriate, honest amount for services, and make sure they are legal services. After all, that’s what we are selling. Avoid folly, and you’ll stay out of disciplinary trouble and stay out of the cross-hairs of billing auditors.

If you or your firm were ordered to pay a party’s legal fees as a “sanction” for professional misconduct, would your professional liability insurance cover that payment?

In a recent case, the district court for the Northern District of Illinois left a law firm high and dry, holding that the policy exclusion for sanctions meant that the insurer did not have to cover attorneys’ fees that its insured, the law firm, had to pay or repay due to its misconduct. Edward T. Joyce & Assocs., P.C. v. Professionals Direct Insurance Co. (PACER identification required for access).

Underlying case

In the long and tortuous underlying case, which began in 2002, the Joyce Firm represented more than 100 individuals and entities as plaintiffs under a contingent fee agreement. After obtaining an arbitration award against the insolvent defendant, the Joyce Firm hired additional co-counsel to help in the second phase of the case by pursuing a claim against the defendant’s insurer. The firm attempted to modify the original fee agreement in 2007, including adding a provision for an “hourly contingent fee.” Eventually, the claim against the insolvent defendant’s insurer resulted in an $8.6 million settlement in favor of the plaintiffs.

Plaintiffs, however, disputed the amount and basis of the Joyce Firm’s fees arising from that settlement, and also disputed who was responsible for paying the additional co-counsel’s fees. Plaintiffs demanded arbitration, seeking, among other things, “equitable disgorgement.” The arbitrator found several instances of misconduct on the part of the Joyce Firm:

it failed to advise the clients to consult independent counsel about the attempted modification of the fee agreement;

it failed to give adequate information about the terms of the new agreement to the many clients;

it presented the new agreement on a take-it-or-leave-it basis; and

the new agreement was not in writing.

The arbitrator determined that “as a sanction,” the Joyce Firm was responsible for paying 25 percent of the co-counsel’s fees, or about $150,000; because the firm’s actions were “not intentional,” though, the plaintiffs were responsible for the remainder. The Joyce firm was also ordered as “a sanction” to repay to the plaintiffs more than $405,000 in fees it had previously collected as “contingent hourly fees” under the attempted 2007 modification of the fee agreement. The trial court confirmed the arbitration award, the court of appeals affirmed, and the state supreme court denied a petition for leave to appeal.

Policy exclusion for “sanctions”

The Joyce Firm was insured under a professional liability policy that excluded from coverage (among other things) “any claim for fines, sanctions, penalties, punitive damages or any damages resulting from the multiplication of compensatory damages.” Although the firm’s insurer agreed to reimburse it for defense costs, the insurer denied any further obligation to indemnify the Joyce Firm — particularly against the more than half million dollars the arbitrator awarded to plaintiffs as a “sanction.”

The Joyce Firm’s resulting declaratory judgment action against the insurer was removed to the District Court for the Northern District of Illinois. There, the district court granted summary judgment in favor of the insurer.

“Sanction,” not “disgorgement”

The Joyce Firm argued that despite the arbitrator’s use of the term “sanction,” he really intended the damages to be in the nature of disgorgement, as he found that the firm did not intend to violate the law or the rules of ethics. (Indeed, “disgorgement” would have been in line with the way the plaintiffs characterized the recovery they sought.)

The district court summarily rejected that argument, citing the arbitrator’s “stated imposition of sanctions,” and the state court of appeals’ affirmance of the arbitration award, which “expressly and repeatedly referred to the damages award as a sanction.” These characterizations were apparently sufficient for the district court; the opinion cites no case authority in support of this prong of its ruling that the insurer had no duty to indemnify the Joyce Firm.

Take-aways: (1) words matter; (2) mind your fees and cues

The Joyce Firm appealed to the Seventh Circuit Court of Appeals on October 23, so the final chapter has not yet been written on this case. But one take-away from the district court’s ruling is that words certainly matter, and that the way in which an arbitrator characterizes an award can have a large impact on insurance coverage issues. The other take-away concerns the law firm’s attempt to modify its contingent fee agreement. Model Rule 1.5(b) requires that once agreed to, any change in the basis or rate of the fee must be communicated to the client. That was apparently not carried out adequately in this case, providing one of the implicit bases for the arbitrator’s award against the firm.

When a lawyer sues a client for unpaid fees, the client must assert any possible claim for legal malpractice as a compulsory counterclaim, the Ohio Eighth District Court of Appeals has held. In other words: use it or lose it. The court upheld summary judgment in favor of a lawyer whose client failed to assert such a counterclaim.

In Harper v. Anthony, the lawyer had represented the client in a divorce case. After the client sued for legal malpractice, the lawyer counterclaimed for unpaid legal fees. When the client failed to answer the counterclaim, the lawyer moved for a default judgment. The client voluntarily dismissed the malpractice claim, leaving the unanswered counterclaim for fees standing. The trial court entered an $11,000 default judgment against the client.

When the client refiled the legal malpractice case, the lawyer moved for summary judgment, arguing that the claim was a compulsory counterclaim to the lawyer’s claim based on unpaid fees, and the client lost it by failing to prosecute it in the first action. The trial court agreed, and the court of appeals affirmed. (The Ohio Supreme Court declined review.)

Under Ohio Civil Rule 13(A), a counterclaim is compulsory if it is logically related to the opposing party’s claim. This met the test, the court held, since the malpractice claim arose out of the same operative facts as the claim for fees.

The client in Harper argued that it was inequitable to require a client to assert a legal malpractice claim at the same time as a lawyer files a suit for unclaimed fees, because the client might not know that a malpractice claim exists until after the unpaid fee dispute is resolved.

But the court of appeals rejected that argument: under Ohio Civil Rule 13(A), a counterclaim is compulsory only if it exists at the time that the pleading is served. The client here had discovered his alleged malpractice claim and sued on it before his former lawyer filed the unpaid-fee counterclaim. Therefore, the client was barred from refiling the same legal malpractice claim.

When you sue a client for unpaid fees, you can often expect a counterclaim for malpractice; here, the shoe was on the other foot. But it is worth remembering that failing to assert a compulsory counterclaim can doom any claim — whether it’s for your fees, or whether it’s a malpractice claim against you.

About this Blog

The Law for Lawyers Today is a resource for law firms, law departments and lawyers needing information to meet the challenge of practicing ethically and responsibly. Here you’ll find timely updates on legal ethics, the “law of lawyering,” risk management and legal malpractice, running your legal business— and more.

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